Private equity as savior and villain

Defining "private equity" is relatively simple. What may be more difficult, depending on your perspective, is determining whether private equity is a productive segment of the financial system.

Private equity represents ownership of companies through stock that is not quoted or traded on a public exchange.

An example of a public equity company could be Google. Investors can buy and sell shares on the stock exchange for known values at any time the exchange is open for business. For every buyer, there is a seller of some sort. And for every seller, there is a buyer.

Price transparency is very high for most public equity. It is relatively simple to see at what price the shares are trading. Trades can be executed very simply. Depending on the volume of shares traded in a particular company on a given day, most investors can move into and out of positions in a public company without too much trouble.

Private equity generally consists of funds contributed by pension plans, retirement plans and other large investors into pools of available capital. It is estimated private equity funds have in excess of $400 billion of capital available for investment. Private equity managers then use the capital in these funds, or pools, to purchase complete ownership in publicly traded or privately owned companies. Private equity investors often target inefficient or underperforming companies.

Once the private equity investors have made their investment in a company, these investors generally have control of the company. Again, there are sellers and buyers in all private equity transactions. As compared to buying and selling shares on an exchange, terms of the private transaction are not always public information.

According to Pitchbook.com, 1,738 private equity deals were completed in 2011. Private equity capital invested in these deals totaled $147 billion.

It is now up to the private equity investors, along with other vested parties, such as company management and employees, to improve the valuation of the purchased company.

Sometimes private equity investors are able to substantially improve the value of companies. Other times, all or most of the investment value is lost. Investors in the pools of capital and the private equity managers participate in the positive and negative results of the investments made.

It can take several years for the efforts of the private equity managers to yield results.

In some circumstances, the private equity managers cut costs and overhead at the acquired companies in an effort to position the companies for future growth, profitability and job creation.

A wide range of corporate restructuring options are available. Private equity managers generate positive returns for their investors by creating incremental value in the investments made. Realization of the positive investment performance often comes from reselling an acquired company to another private buyer or by selling shares in the public markets.

Value creation is a key focus of a private equity investor. Patience on the part of the investors in a private equity fund is critical to the success of the investment.

Confidence in the private equity manager by the fund investors is also important. Private equity seeks to improve the value of companies and provide attractive returns for their investors.